CASE 8-1: NORMAN CORPORATION
1. Answer: The transaction should be recognized based on the following points: i. ii. Conservatism concept stated that expenses should be recognized as soon as they are reasonably possible to occur. According to loss contingency, a liability is recognized when information available indicates that it is probable for a liability to occur and when the amount of loss can be reasonably estimated. Therefore, Norman should provide a provision for loss and recorded the transaction as a liability and an expense. The journal entries would be as follow: Dr. Cr. Lawsuit Loss Lawsuit Liability $250,000 $250,000 Lawsuit Loss will be recorded in Income Statement under Non-operating Expenses while Lawsuit Liability will be recorded in Balance Sheet under Current Liabilities (as the trial will be held on 2011). Customer asked for $500,000 damage. After discussion with customer’s attorney, Norman’s attorney believed that the suit could be settled for $50,000 (no guarantee). If the suit went to trial, Norman might win it Norman reported $50,000 as a Reserve for Contingencies which is a debit to Retained Earnings. 2.

Answer: In this case, there is a provision for lawsuit loss of $50,000. However, the provision should be recognized as an expense instead of directly debit to Retained Earnings. Thus, instead of recording the provision as Reserve for Contingencies, it should be recorded as Lawsuit Loss just as for transaction above. The journal entries would be as follow: Dr. Cr. Lawsuit Loss Lawsuit Liability $50,000 $50,000 Lawsuit Loss will be recorded in Income Statement under Non-operating Expenses while Lawsuit Liability will be recorded in Balance Sheet under Liabilities. Normally it was $ 60,000 a year and this amount been budgeted for 2010. Estimated income statement included $60,000 for plant maintenance expense. Offsetting credit of $16,000 to a reserve account (non-current liability). 3.

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